Determining your investor profile and understanding your risk tolerance is an important step before investing, your risk tolerance will determine your appropriate asset allocation. There are several factors that determine your risk tolerance among other things are your age, networth, time horizon and investing experience.
Risk Tolerance is not a static measure; it changes over time (or at least should) in an ideal situation your risk tolerance should look like this (the age is a very rough estimate):
• Early Earning Years (to age 35): At this time you are starting a career, building net worth and assuming family and home ownership responsibilities. The most common priorities are to have a savings plan and near-cash investments for emergency fund. When funds are available for investing, growth is usually the primary objective.
• Mid-Earning Years (to age 55): In this stage your expenses usually decline and income and savings usually increase. Therefore, savings continue to be a very important factor in the growth of your investment capital. Because at this stage you have more discretionary income, investment objectives tend to focus on growth and tax minimization.
• Peak Earning Years (up to retirement): As you approach retirement, preservation of capital becomes an increasingly important objective. During this period, the average term of maturity of fixed-income investments should be shortened and the quantity of higher-risk common shares reduced.
• Retirement Years: During this period you will most likely have fixed income and only limited opportunities for employment. Therefore the primary investment objectives of retired individuals are preservation of capital and income. There must be enough growth in the portfolio so that you do not run out of money.
At different stages in your life you will have different priorities, different risk tolerance and your investor profile should reflect that. You most likely have already filled out an “investor profile” questionnaire to determine your risk tolerance, it asks you between 10-20 questions and gives you a score which is your “risk tolerance”. If you have not seen one yet, do not worry later on during the week I will provide you with a sample.
Ray is an ex-financial adviser and the founder of Financial Highway. Currently working in the financial industry and working towards completing his Chartered Financial Analyst, CFA, designation.